Online retailers call Internet sales tax a 'nightmare'

Small online retailers, like Kevin Hickey, worry about the costs of complying with an Internet sales tax.

The nation is one step closer to an Internet sales tax that some online retailers think would be compliance hell.

Online retailers would have to start collecting sales tax upfront. They'd also be forced to send payments to local governments across the country. The "Marketplace Fairness Act" passed the Senate but faces a higher hurdle in the House of Representatives before becoming law.

The law would apply to online sellers that have total annual sales of at least $1 million outside of states where they have physical presence.

Justin Krauss is worried about the paperwork burden it would place on his tiny company, Garage Flooring.

His business has annual revenues just above the million dollar threshold and racks up as many as 36,000 transactions a year. The vast majority are outside his home base in Grand Junction, Colo.

There are only four states that have no sales tax. Krauss would have to cut quarterly checks to the other 46.

"I didn't sign up to be a tax collector," he said. "The federal and state governments are putting the burden on small businesses."

Krauss says he'd have to update his accounting software, hire a computer programmer to update his virtual shopping cart system, then continuously file a steady stream of paperwork. The initial effort could cost him $40,000, he estimates.

After that, he could rely on an accounting software provider to process transactions and file the paperwork for about $4,000 a year. It's not a huge sum, but Krauss argues most online retailers are operating on thin profit margins already.

"That's coming out of somebody's paycheck," Krauss said. "That's a Christmas bonus that's not being received."

The bill does say states must provide tax free software. But online retailers who spoke to CNNMoney doubt all 46 states will provide software that works with every digital shopping cart, especially when so many of the businesses use proprietary software specifically tailored for their company.

Besides, businesses would still need to hire additional staff to account for the added work of plugging in their products -- which sometimes number in the thousands -- into the taxing software.

Brian Walsh, a spokesman for the group pushing for the law, called those worries a red herring, because any worries about whether the software will be compatible should be worked out.

"If there are legitimate issues that should be looked at, we expect the House of Representatives will do that," said Walsh on behalf of the Marketplace Fairness Coalition, which includes retailers like Best Buy(BBY), Target(TGT), and Amazon(AMZN).

Natalie Mai, a small business tax attorney in Oklahoma City, doesn't represent Krauss. But she said many online shops of similar size won't be able to bear the cost of compliance. Even storefronts that only deal with one sales tax rate have a difficult time when business gets overwhelming and ledgers get messy.

"If you're a mom-and-pop shop online, I doubt you'll be able to stay in business," she said.

eBay: 'Not against an Internet sales tax'

There are maybe 7,500 businesses that would be affected by the law, according to a study commissioned by Amazon, which has voiced strong support for the bill.

Supporters say the proposed law levels the playing field between online retailers and storefronts. If you walk into a Miami store and spend $100, it'll cost you an extra $7 in sales tax. Buy the product online, and you'll only pay $100.

Kevin Hickey's company outside Pittsburgh, Online Stores, sells everything from flags to English tea to construction equipment. It's one of those do-everything retailers that essentially serves as an online wholesaler, competing with similar firms all over the world.

That means its profit margin is practically nonexistent. It has annual revenues of $30 million and might clear $400,000 in profit this year.

His greatest fear is being subject to another tax audit, like one he went through in 2006. State officials found that he should have been paying taxes on shipping fees -- not just products -- and it cost him $15,000 in back taxes and penalties.

Hickey is worried the new law would mean audits from California, Texas and elsewhere.

The bill does provide protection from audits if online retailers use free government software. But again, businesses don't expect they'll even use that software due to compatibility issues.

"It's basically impossible to collect the sales tax correctly for all states. The chance of us collecting all sales tax correctly all the time is zero," he said.

A previous version of this article did not note that the bill demands states provide free software that blocks audits.